In 1998 the IRS and the Treasury Department got the attention of the outbound international tax community by issuing Notice 98-5. The notice sought to challenge certain tax-motivated transactions that generated foreign tax credits (FTCs) by testing their substance under an economic profits test. The transactions described in Notice 98-5 were later included as "listed transactions" subject to the tax shelter disclosure, registration and list maintenance requirements.
Given the recent IRS emphasis on policing listed transactions, some practitioners were surprised this February when the IRS issued Notice 2004-19 withdrawing Notice 98-5. In Notice 2004-19, the IRS said it will no longer seek to apply an economic-profits test to challenge abusive FTC transactions. In addition, the transactions described in Notice 98-5 will no longer be "listed" transactions, although other transactions may be added to the list.
The IRS now plans to issue regulations addressing certain transactions or structures that produce "inappropriate" FTC results, either by disallowing FTCs, or reallocating foreign taxes. Specifically, proposed regulations described in Notice 2004-19 would address allocations of foreign taxes that are inconsistent with the allocation of related foreign income.
In addition, Notice 2004-19 highlights a legislative proposal included in this year's Treasury Budget (see International Tax Review, 'US Outbound Update', February 2004, page 41) that would extend certain holding periods for FTCs. Finally, the notice states the IRS will continue to challenge FTC benefits arising from "abusive" transactions by applying existing judicial doctrines such as substance over form and step transactions, as well as statutory and regulatory anti-abuse rules.
The withdrawal of the economic profits test seems to be an important change in how the IRS will police the FTC regime. But until the promised regulations are published, the ultimate impact of Notice 2004-19 is not clear.
Sean Foley (sffoley@kpmg.com), Washington, DC
